Chapter 2 Demand

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  • Chapter 2 Demand

    1. 1. Demand of Goods and Services
    2. 2. Classification of Goods and Services <ul><li>From conventional perspective </li></ul><ul><ul><li>Free goods </li></ul></ul><ul><ul><li>Public goods </li></ul></ul><ul><ul><li>Economic goods </li></ul></ul><ul><li>From Islamic perspectives </li></ul><ul><ul><li>Al-tayyibat </li></ul></ul><ul><ul><li>Al-Rizq </li></ul></ul>
    3. 3. Conventional Perspectives <ul><li>Free Good </li></ul><ul><li>Goods that have no production cost (air, sunlight, rain </li></ul><ul><li>water). </li></ul><ul><li>Public Goods </li></ul><ul><li>Goods that have a common use and are benefit to </li></ul><ul><li>everyone (public clinics, schools, hospital and others.) </li></ul><ul><li>Economic goods </li></ul><ul><li>Goods which supply is limited and require costs to </li></ul><ul><li>purchase them (books, clothes, houses, movies) </li></ul><ul><li>Price is involved in obtaining them. </li></ul>
    4. 4. Islamic Perspective <ul><li>Al-Tayyibat </li></ul><ul><li>Al-tayyibat means good things, clean and pure things, and sustenance of the best. </li></ul><ul><li>Bad goods are not considered as goods in Islam. </li></ul><ul><li>Al- Rizq </li></ul><ul><li>Al-rizq is used to denote the following meanings; </li></ul><ul><ul><li>- Godly sustenance, godly provision and heavenly gifts </li></ul></ul><ul><li>All these meanings denote that Allah s.w.t is the only sustainer and provider for all creatures. </li></ul>
    5. 5. Hierarchy of needs <ul><li>Dharuriyah </li></ul><ul><ul><li>Goods that are classified as basic needs and necessary for a living. eg: food, cloth </li></ul></ul><ul><li>Hajiyat </li></ul><ul><ul><li>Goods that will improve the quality of human life eg: refrigerator, radio </li></ul></ul><ul><li>Kamaliat </li></ul><ul><ul><li>Goods that contribute towards the perfection of human life (luxury goods). Eg: bungalow house, Mercedes cars </li></ul></ul><ul><li>Tarafiat </li></ul><ul><ul><li>Not permissible (haram). Bring negative impact on society. Not only extravagant and wasteful, but also cause harm to man. Eg: liquor </li></ul></ul>
    6. 6. DEMAND OF GOODS AND SERVICES
    7. 7. Definition of demand <ul><li>The quantity of various goods that people are willing and able to buy at a particular time and at a given range of prices. </li></ul>
    8. 8. DEMAND SCHEDULE AND DEMAND CURVE <ul><li>Demand Schedule </li></ul><ul><ul><li>The demand schedule is a table that shows the relationship between the price of the good and the quantity demanded </li></ul></ul><ul><li>Demand Curve </li></ul><ul><ul><li>A demand curve is a graphical representation of a demand schedule. </li></ul></ul><ul><ul><li>A graph of the relationship between the price of a good and the quantity demanded. </li></ul></ul><ul><ul><li>slopes downward and to the right. </li></ul></ul>
    9. 9. Figure 1 Siti’s Demand Schedule and Demand Curve Copyright © 2004 South-Western Price of Ice-Cream Cone 0 2.50 2.00 1.50 1.00 0.50 1 2 3 4 5 6 7 8 9 10 11 Quantity of Ice-Cream Cones $3.00 12 A B 1. A decrease in price ... 2. ... increases quantity of cones demanded.
    10. 10. The Individual Demand Curve and the Law of Demand Demand Schedule for Pizza Price ($) Quantity of pizzas per month 2 13 4 10 6 7 8 4 10 1
    11. 11. The Individual Demand Curve and the Law of Demand <ul><li>The individual demand curve shows the relationship between the price of a good and the quantity that a single consumer is willing to buy, or quantity demanded. </li></ul><ul><li>The law of demand states that the higher the price, the smaller the quantity demanded, ceteris paribus (Other thing remain constant). </li></ul>
    12. 12. WHY? <ul><li>The Substitution Effect </li></ul><ul><li>consumers react to an increase in a good’s price by consuming less of that good and more of other goods. </li></ul><ul><li>The Income Effect </li></ul><ul><li>a person changes his or her consumption of goods and services as a result of a change in real income. </li></ul>
    13. 13. Market Demand <ul><li>Market demand is the sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service. </li></ul>
    14. 14. <ul><li>From Individual Demand to Market Demand </li></ul><ul><li>market demand curve A curve showing the relationship between price and quantity demanded by all consumers, ceteris paribus. </li></ul><ul><li>Table 1.1 From Individual to Market Demand </li></ul>
    15. 15. How to calculate market demand? Price Ind.1 Ind. 2 Market Demand RM 2.00 600 300 (600 + 300) = 900 RM 3.00 400 200 RM 4.00 200 100 RM 5.00 100 50
    16. 16. Changes in Quantity Demanded 0 D Price of Ice-Cream Cones Quantity of Ice-Cream Cones A tax that raises the price of ice-cream cones results in a movement along the demand curve. A 8 1.00 <ul><li>Change in Quantity Demanded </li></ul><ul><ul><li>Movement along the demand curve. </li></ul></ul><ul><ul><li>Caused by a change in the price of the product. </li></ul></ul>B $2.00 4
    17. 17. DEMAND SHIFTER
    18. 18. SHIFTS IN THE DEMAND CURVE Tastes Income Number of buyers Expectations Prices of related goods ♥ Shift factors of demand are factors that cause shifts in the demand curve
    19. 19. Shifts in the Demand Curve <ul><li>Recall our assumption </li></ul><ul><ul><li>hold other things constant – ceteris paribus allow only price to change </li></ul></ul><ul><li>But what if other factors do change? </li></ul><ul><ul><li>change in demand </li></ul></ul><ul><ul><li>shift to a new demand curve, either to the left or right. </li></ul></ul><ul><ul><li>alters the quantity demanded at every price. </li></ul></ul>
    20. 20. Figure 3 Shifts in the Demand Curve Copyright©2003 Southwestern/Thomson Learning Price of Ice-Cream Cone Quantity of Ice-Cream Cones 0 Increase in demand Decrease in demand Demand curve, D 3 Demand curve, D 1 Demand curve, D 2
    21. 21. D 1 D 2 P QD 1 QD 2 Change in Income [Normal-Direct; Inferior-Inverse] More income results in more demand for new cars; less demand for used cars. New Cars Used Cars Less income results in more demand for used cars; less demand for new cars.
    22. 22. The Impact of a Change in Income <ul><li>Higher income decreases the demand for an inferior good </li></ul><ul><li>Higher income increases the demand for a normal good </li></ul>
    23. 23. Change in Income <ul><li>An increase in income will lead to an increase in demand for most goods & services because the amount of purchasing power increases, vice versa </li></ul><ul><li>As consumer’s income rises, the demand for higher quality goods will certainly increase (shown by the shift of dd curve to right)  normal good </li></ul><ul><li>Products for which demand declines as income rises  inferior good </li></ul>
    24. 24. Complement [ Inverse ] Substitute [ Direct ] Milk Cereal Pop Tarts D 1 D 2 P P 1 QD 1 P 2 D 1 D 2 D P Prices of Related Goods [Substitutes-Direct; Complements-Inverse] QD 2
    25. 25. Prices of Related Goods <ul><li>Changes in the price of substitutes </li></ul><ul><ul><ul><li>Rise in prices of one good lead to a contraction in the quantity of the good demanded & increase in the demand for its substitutes </li></ul></ul></ul><ul><li>Changes in the price of complements </li></ul><ul><ul><ul><li>Goods that are consumed together. When demand for one good rises, so does demand for the other. </li></ul></ul></ul>
    26. 26. D 1 D 2 P QD 1 QD 2 &quot;Change in Taste&quot; [Direct] An increase in taste for DVDs results in an increase in demand . A decrease in taste for videos results in a decrease in demand . D 3 QD 3
    27. 27. D 1 D 2 P QD 1 QD 2 Expectations [of consumers] [about future price, availibility, & income] iPhone $399 Buy it now to save money.
    28. 28. D 1 D 2 P QD 1 QD 2 Expectations [of consumers] [about future availibility of toilet tissue] If there is expected to be a major shortage of toilet tissue , then consumers will stock up now or risk not getting any.
    29. 29. D 1 D 2 P QD 1 QD 2 Expectations [of consumers] [about future income] Let’s say that we are coming out of recession & consumers feel secure about their jobs. [ Positive future income ]
    30. 30. D 1 D 2 P QD 1 QD 2 Expectations [of consumers] [about future income] Let’s say that we are going into a recession and consumers don’t feel secure about their jobs. [ Negative future income ]
    31. 31. D 1 D 2 P QD 1 QD 2 Change in Market Size [Direct] [Number of Consumers] More demand for both normal & inferior goods New Cars Used Cars
    32. 32. When price changes, what happens? <ul><li>The curve does not shift. </li></ul><ul><li>There is a change in the quantity demanded </li></ul>
    33. 33. $20 $15 $10 $5 10 20 30 40 A B A change in price causes a change in the quantity demanded D P Q 50
    34. 34. When something changes other than price, what happens? <ul><li>The whole curve shifts,there is a change in demand </li></ul>
    35. 35. Change in Quantity Demanded vs. Change in Demand Change in quantity demanded Change in demand <ul><li>Refer to a movement along a given demand curve </li></ul><ul><li>As a result of a change in the commodity price (price of the good itself whereas other factors influencing demand remains unchanged) </li></ul><ul><li>Refer to a shift in the demand curve (left / right) </li></ul><ul><li>As a result of a change in the economics variable and not the price of the good itself </li></ul>
    36. 36. A Change in Demand Versus a Change in Quantity Demanded To summarize : Change in price of a good or service leads to Change in quantity demanded ( Movement along the curve ). Change in income, preferences, or prices of other goods or services leads to Change in demand ( Shift of curve ).
    37. 37. The Exceptional Demand Curve <ul><li>Normal dd curve is always downward sloping showing inverse relationship between price of a good and quantity demanded </li></ul><ul><li>However, there is a possibility that price increases, the quantity demanded also increases @ quantity demanded of a good decreases when its price falls </li></ul><ul><li>Divided into 2 </li></ul><ul><ul><ul><li>Regressive at high prices </li></ul></ul></ul><ul><ul><ul><ul><li>Happens to luxury goods like antique and jewellery items </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Bought by the rich to show off their status </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Higher price  more goods would be demanded </li></ul></ul></ul></ul><ul><ul><ul><li>Regressive at low price </li></ul></ul></ul><ul><ul><ul><ul><li>Happens to inferior goods like broken rice and salted fish </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Lower the price offered, fewer would be demanded by the poor  substitute the existing goods to better quality goods </li></ul></ul></ul></ul>
    38. 38. Luxuries goods <ul><li>Those products that have an income elasticity of demand greater than 1. </li></ul><ul><li>The more expensive the goods, the greater will be the demand. </li></ul><ul><li>Jewellery, antique furniture, picture of Mona Lisa etc </li></ul>Exceptional dd curve regressive at high price Q P d
    39. 39. Exceptional Demand <ul><li>Doesn't follow the law of demand </li></ul><ul><li>Giffen goods </li></ul><ul><ul><li>The demand curve for giffen goods is normally upward sloping. </li></ul></ul><ul><ul><li>Purchasing power has increase, which allowed people to replace with better quality goods </li></ul></ul>Exceptional dd curve regressive at low price P Q d
    40. 40. ELASTICITY OF DEMAND <ul><li>Definition: </li></ul><ul><li>Elasticity means responsiveness or sensitivity. Therefore elasticity of demand means the responsiveness of demand due to the changes of the factors that influence demand. </li></ul>
    41. 41. Types of Elasticity: <ul><li>Price elasticity of demand </li></ul><ul><li>Cross elasticity of demand </li></ul><ul><li>Income elasticity of demand </li></ul><ul><li>Price elasticity of supply </li></ul>
    42. 42. i. Price Elasticity of Demand (Ed) <ul><li>Ed measures the responsiveness of the quantity demanded due to the change in its price. </li></ul><ul><li>Ed tries to measure how much does demand has decreased when price increased </li></ul><ul><li> </li></ul>
    43. 43. <ul><li>Calculating price elasticity of demand; </li></ul><ul><li>Formula: </li></ul><ul><li>Ed = ( % ∆ in Qd for product X) </li></ul><ul><li> % ∆ in P of product X </li></ul><ul><li>= % ∆ in Q </li></ul><ul><li> % ∆ in P </li></ul><ul><li>= ( ∆ Q) x P 0 </li></ul><ul><li> Q 0 ∆P </li></ul><ul><li>= ( Q 1 – Q 0 ) x P 0 </li></ul><ul><li> Q 0 (P 1 – P 0 ) </li></ul>
    44. 44. <ul><li>Example: </li></ul><ul><li>Price(RM) Quantity Demanded </li></ul><ul><li>2.00 10 </li></ul><ul><li>3.00 5 </li></ul><ul><li>Calculate the price elasticity of demand when price increases from RM2.00 to RM3.00. </li></ul>
    45. 45. <ul><li>Ed = ∆ Q x P 0 </li></ul><ul><li> Q 0 ∆ P </li></ul><ul><li>= ( Q 1 – Q 0 ) x P 0 </li></ul><ul><li> Q 0 (P 1 – P 0 ) </li></ul><ul><li>= ( 5 – 10 ) x 2 </li></ul><ul><li> 10 (3 – 2) </li></ul><ul><li>= -1 </li></ul><ul><li># If price of good X increases by 1%, quantity of good X demanded will decrease by 1% </li></ul>
    46. 46. Degrees of Price Elasticity of Demand <ul><li>Elastic demand (Ed > 1) </li></ul><ul><li>Percentage change in quantity demanded is greater then the percentage change in price. </li></ul><ul><li>%Δ Q > %Δ P </li></ul>P Q D D Smooth line dd curve
    47. 47. ii. Inelastic demand (0<Ed<1) or (Ed < 1) <ul><li>Percentage change in quantity is less than the percentage change in price. </li></ul><ul><li>%Δ Q < %Δ P </li></ul>P Q D D Steep line dd curve
    48. 48. iii. Unitary elastic (Ed = 1) <ul><li>Percentage change in quantity demanded is equal to the percentage change in price. </li></ul><ul><li>%Δ Q = %Δ P </li></ul>D P X Hyperbola line dd curve
    49. 49. iv. Perfectly Elastic (Ed = ∞) <ul><li>Percentage change in quantity demanded is infinite in relation to the percentage change in price  small % change in price of a good would lead to infinite changes in its quantity demanded </li></ul>P Q D P 0 Horizontal line demand curve
    50. 50. v. Perfectly Inelastic (Ed = 0 ) <ul><li>Quantity demanded does not change as the price changes. </li></ul>P Q Q 0 D P 1 P 2
    51. 51. Determinants of Price Elasticity of Demand <ul><li>Availability of substitutes </li></ul><ul><li>many substitutes  more elastic dd </li></ul><ul><li>less/no substitutes  less elactic/ inelastic dd </li></ul><ul><li>Eg: petrol and detergents (liquid, soap) </li></ul><ul><li>Relative importance of the goods in the budget </li></ul><ul><li>greater the income spent  more elastic dd </li></ul><ul><li>Eg: dd for house is more elastic compared to demand for detergents because money spent on houses is greater than money spent on detergents. </li></ul>
    52. 52. <ul><li>Time frame </li></ul><ul><li>In short run  less elastic/ inelastic dd </li></ul><ul><li>In the long run demand  more elastic because consumers can make adjustment and find other substitutes. </li></ul><ul><li>The importance of goods – necessity or luxury </li></ul><ul><li>Necessity good  inelastic dd </li></ul><ul><li> eg: rice (great increase in price will not reduce the demand for rice very much). </li></ul><ul><li>Luxury goods/ less important goods  elastic dd </li></ul><ul><li>The number of usage </li></ul><ul><ul><li>many number of usage  more elastic compared to goods that have fewer usage. Eg: demand for rubber is more elastic because it can be processed into rubber hoses, tyres, gloves, & etc </li></ul></ul>
    53. 53. <ul><li>Income level </li></ul><ul><li>higher income people  inelastic dd. </li></ul><ul><li>lower income group  elastic dd (sensitive to price changes) </li></ul><ul><li>Habits </li></ul><ul><li>habits  inelastic dd. </li></ul><ul><li>Eg: demand for cigarette by smokers. </li></ul>
    54. 54. Relationship between price elasticity of demand and total revenue (TR) <ul><li>Important for producers to decide whether they should increase, decrease or maintain the price of the good they sold in the market to enable them to maximize their profit </li></ul><ul><li>TR = price x quantity </li></ul><ul><li>TR increases or decreases when there is price changes depend on the price elasticity of demand. </li></ul><ul><li>i. If demand is elastic, to increase TR, price should be decreased. </li></ul><ul><li>ii. If demand is inelastic, to increase TR, price should be increased. </li></ul><ul><li>iii. If demand is unitary elastic, change in price would not affect and change in TR. </li></ul>
    55. 55. (i) Inelastic demand (Ed<1) Assume price increases from RM10 to RM15 Price (RM) Quantity (units) 8 10 10 15 Steep line demand curve TR before = RM10 x 10 = RM100 TR after = RM15 x 8 = RM120 (TR increases) # If demand is inelastic, an increase in price will lead to an increase total revenue & vice versa
    56. 56. ii) Elastic demand (Ed>1) Assume that price increases from Rm10 to RM11 Smooth line demand curve P Q 7 10 10 11 TR before = RM10 x 10 = RM100 TR after = RM11 x 7 = RM77 (TR decreases) # If demand is elastic, an increase in price will lead to a decrease in total revenue.
    57. 57. iii) Unitary elastic demand (Ed=1) Assume that price increases from RM10 to RM20 20 10 10 20 P Q TR before = RM10 x 20 = RM200 TR after = RM20 x 10 = RM200 (TR remains the same) # If demand is unitary elastic, an increase in price will make total revenue remains the same Hyperbola line dd curve
    58. 58. The R/ship between TR & Price Elasticity of Demand when Price Increases Elasticity Coefficient Price Elasticity of Demand Price Quantity Demanded Total Revenue Ed>1 Elastic Increases Decreases more than proportionate Decreases Ed=1 Unitary elastic Increases Decreases in exact proportion Remain the same Ed<1 Inelastic Increases Decreases less than proportionate Increases
    59. 59. The R/ship between TR & Price Elasticity of Demand when Price Decreases Elasticity Coefficient Price Elasticity of Demand Price Quantity Demanded Total Revenue Ed>1 Elastic Decreases Increases more than proportionate Increases Ed=1 Unitary elastic Decreases Increases in exact proportion Remain the same Ed<1 Inelastic Decreases Increases less than proportionate Decreases
    60. 60. Cross Elasticity of Demand (Exy) <ul><li>Exy measures the responsiveness of quantity demanded for one product to a change in the price of another product. </li></ul><ul><li>Formula: </li></ul><ul><li>Exy = % ∆ in Qx </li></ul><ul><li>% ∆ in Py </li></ul><ul><li>= ∆ Qx x Py 0 </li></ul><ul><li> ∆ Py Qx 0 </li></ul><ul><li>= ( Qx 1 – Qx 0 ) x Py 0 </li></ul><ul><li> (Py 1 – Py 0 ) Qx 0 </li></ul>
    61. 61. <ul><li>Exy < 0  product X is a complement of product Y </li></ul><ul><li>Exy > 0  product X and Y are substitutes for one another </li></ul><ul><li>Exy = 0  product X and Y are independent for one another </li></ul>
    62. 62. <ul><li>Example: </li></ul><ul><li>Price of Y Quantity x Quantity Y </li></ul><ul><li>RM10 60 15 </li></ul><ul><li>RM18 40 25 </li></ul><ul><li>RM25 20 30 </li></ul><ul><li>Calculate the cross elasticity of demand for good x when the price of y increases from RM18 to RM25 </li></ul>
    63. 63. <ul><li>Answer: </li></ul><ul><li>Formula : </li></ul><ul><li>= ∆ Qx x Py 0 </li></ul><ul><li> ∆ Py Qx 0 </li></ul><ul><li>= ( Qx 1 – Qx 0 ) x Py 0 </li></ul><ul><li> Qx 0 Py 1 – Py 0 </li></ul><ul><li>= 20 - 40 x 18 </li></ul><ul><li> 40 25 - 18 </li></ul><ul><li>= -1.29 </li></ul><ul><li>Conclusion; </li></ul><ul><li>Goods x and y are complement </li></ul>
    64. 64. Income Elasticity of Demand (Ey) <ul><li>Ey measures the responsiveness of quantity demanded to a change in income. </li></ul><ul><li>Three possibilities: </li></ul><ul><li>i. If Ey is positive = normal goods - </li></ul><ul><li>Ey >1 - luxury </li></ul><ul><li> Ey ≤ 1 – necessity </li></ul><ul><li>ii. If Ey is negative = inferior goods </li></ul><ul><li>iii. If Ey is zero = essential goods </li></ul><ul><li>Eg. Ey = 5  if income increase 1%, quant. demanded for good X will increase by 5% </li></ul><ul><li>Ey = 0  if income changes, quant. demanded for good B remains unchanged </li></ul>
    65. 65. <ul><li>Formula: </li></ul><ul><li>Ey = % ∆ in Q </li></ul><ul><li>% ∆ in Y </li></ul><ul><li>= ∆ Q x Y 0 </li></ul><ul><li> ∆ Y Q 0 </li></ul><ul><li>= ( Q 1 – Q 0 ) x Y 0 </li></ul><ul><li> (Y 1 – Y 0 ) Q 0 </li></ul><ul><li>= (Q 1 – Q 0 ) x Y 0 </li></ul><ul><li> Q 0 (Y 1 – Y 0 ) </li></ul>
    66. 66. <ul><li>Example: </li></ul><ul><li>Income Qty A Qty B Qty C </li></ul><ul><li> 100 10 20 20 </li></ul><ul><li> 120 15 20 18 </li></ul><ul><li> 150 17 20 14 </li></ul><ul><li>Calculate the income elasticity of demand for goods A, B and C when income increases from RM120 to RM150. </li></ul>
    67. 67. <ul><li>Good A : </li></ul><ul><li>Ey = ( QA 1 – QA 0 ) x Y 0 </li></ul><ul><li> QA 0 (Y 1 – Y 0 ) </li></ul><ul><li>= (17 – 15) x 120 </li></ul><ul><li> 15 (150 – 120) </li></ul><ul><li>= 0.53 </li></ul><ul><li>Since Ey is positive and < 1, good A is a necessity good </li></ul><ul><li>When Y increase by 1%, quant. demanded for good A increase by 0.53% </li></ul>
    68. 68. <ul><li>Good B : </li></ul><ul><li>Ey = ( QB 1 – QB 0 ) x Y 0 </li></ul><ul><li> QB 0 (Y 1 – Y 0 ) </li></ul><ul><li>= (20 – 20) x 120 </li></ul><ul><li> 20 (150 – 120) </li></ul><ul><li>= 0 (Good B is essential good) </li></ul><ul><li># if Y change, q.demanded for good B remains unchanged </li></ul>
    69. 69. <ul><li>Good C: </li></ul><ul><li>Ey = ( QC 1 – QC 0 ) x Y 0 </li></ul><ul><li> QC 0 (Y 1 – Y 0 ) </li></ul><ul><li>= (14 – 18) x 120 18 (150 – 120) </li></ul><ul><li>= - 0.89 </li></ul><ul><li>Good C is an inferior good </li></ul><ul><li>When Y increase by 1%, quantity demanded for good C decrease by 0.89% </li></ul>

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